European Government Bond Research Articles

From Menace to Mundane: Moral Hazard and the Politics of the European Central Bank's Government Bond Purchases

AbstractDuring the Eurozone's sovereign debt crisis, the ideational consensus that shaped the foundation of Economic and Monetary Union (EMU) was destabilized by disagreement on unconventional monetary policies (UMPs), specifically government bond purchases. In the ECB's 2021 strategy review, however, UMPs were confirmed as standard elements of the European Central Bank's (ECB) toolbox. What happened? One argument frequently presented to question the legitimacy of UMPs is that they undermine the prior objective of the EMU of avoiding moral hazard. We analyse the politics of UMPs by focusing upon how top officials in four major Eurozone central banks have discursively constructed the relationship between the ECB's purchase of sovereign debt and moral hazard. We find that top central bank officials aligned to a large degree on the non‐necessary causal relationship between government bond purchases and moral hazard, which reinforced its legitimacy and eventual acceptance as ‘conventional’.

Sovereign Bond Yield Differentials across Europe: A Structural Entropy Perspective

This study uses structural entropy as a valuable method for studying complex networks in a macro-finance context, such as the European government bond market. We make two contributions to the empirical literature on sovereign bond markets and entropy in complex networks. Firstly, our article contributes to the empirical literature on the disciplinary function of credit markets from an entropy perspective. In particular, we study bond yield differentials at an average daily frequency among EU countries' 10-year Eurobonds issued between 1 January 1997, and 4 October 2022. Secondly, the article brings a methodological novelty by incorporating an entropy perspective to the study of government bond yield differentials and European capital market integration. Entropy-based methods hold strong potential to bring new sources of dynamism and valuable contributions to the areas of macroeconomics and finance.

A Model to Quantify the Risk of Cross-Product Manipulation: Evidence from the European Government Bond Futures Market

A Model to Quantify the Risk of Cross-Product Manipulation: Evidence from the European Government Bond Futures Market

The determinants of sovereign risk premiums in the UK and the European government bond market: the impact of Brexit

This paper analyzes recent developments in the British and European government bond markets with reference to the UK’s decision to leave the European Union. The two main goals of the study are, firstly, to examine whether the Brexit referendum result has affected the risk premium and, secondly, whether there are any changes in risk pricing following the referendum. The paper finds a significant impact of the Brexit referendum on the risk premium in selected economies. Furthermore, the results suggest that there is a considerable change in risk pricing after the announcement of the referendum result. Credit default risk and the risk aversion play a much important role in the post-referendum period than they did prior to the vote, particularly in the UK.

Heterogeneous Effects of Unconventional Monetary Policy on the Bond Yields across the Euro Area

AbstractThis paper investigates the impact of the European Central Bank's unconventional monetary policies (UMP) between 2008 and 2019 on European government bond yields. It adopts a novel econometric approach that combines a data‐rich factor analysis and Vector autoregression (VAR) with heteroskedastic‐based identification. The results identify a significant and substantial impact for all countries and maturities, but stronger and persistent impact for the periphery. When we decompose the impact into separate components, we find that UMP decreases the market component for all countries. It decreases the risk‐mutualization component for the periphery permanently at the cost of a small increase for the core countries, which provides evidence for risk‐mutualization in the EMU.

Price effects of unconventional monetary policy announcements on European securities markets

This paper assesses the effects of the unconventional monetary policies taken by the European Central Bank, the Bank of England and the Federal Reserve on European securities markets. Using the event study methodology, we evaluate the price reaction of market indices around the announcement dates from 2008 to 2018. Our results show that the impact is mixed on European government bonds, but positive and significant on stocks, with some evidence of international spillovers. We also find that coordinated policy actions exert a stronger influence than individual measures. Furthermore, the announcements generate surprise effects, albeit with a different magnitude and direction.

The COVID-19 Pandemic and Sovereign Bond Risk

Governments around the world are tackling the COVID-19 pandemic with a mix of public health, fiscal, macroprudential, monetary, and/or market-based policies. We assess the impact of the pandemic in Europe on sovereign CDS spreads using an event study methodology. We find that a higher number of cases and deaths and public health containment responses significantly increase the uncertainty among investors in European government bonds. Other governmental policies magnify the effect in the short run as supply chains are disrupted. Moreover, an increased debt-to-GDP ratio significantly boosts the cumulative abnormal change of CDS spreads, which indicates that investors are concerned about countries that are too indebted and thus have a limited capacity to intervene and provide fiscal stimuli and emergency fiscal packages to businesses and households.

Volatility forecasting in European government bond markets

In this paper we examine the predictive power of the heterogeneous autoregressive (HAR) model for the return volatility of major European government bond markets. The results from HAR-type volatility forecasting models show that past short- and medium-term volatility are significant predictors of the term structure of the intraday volatility of European bonds with maturities ranging from 1 year up to 30 years. When we decompose bond market volatility into its continuous and discontinuous (jump) component, we find that the jump component is a significant predictor. Moreover, we show that feedback from past short-term volatility to forecasts of future volatility is stronger in the days that precede monetary policy announcements.

Risk premia and the European government bond market: new empirical evidence and some thoughts from the perspective of the life insurance industry

We study yield spreads between government bonds in the European Monetary Union. This segment of the global fixed income market is of particular importance for insurance companies in Europe. Our empirical research strategy is inspired by Gunay (2020) who has analyzed the relationship between credit and liquidity risk in the United States using Granger causality tests. More specifically, we employ the procedure developed by Toda and Yamamoto (1995) to test for Granger causality among yield spreads in five different member countries of the European Monetary Union (namely Austria, Belgium, France, Italy and Ireland) relative to Germany. We examine interest rate data from bonds with three different maturities (5, 10 and 30 years). Given the importance of long-term bonds as asset class for European life insurers and pension funds, the empirical results from the often ignored market for government bonds with a maturity of 30 years should be of interest. With regard to long-term sovereign debt, there is no evidence for Granger causality among the time series examined here. Consequently, the risk premia required by investors to hold government bonds of one specific member country of the EMU do not help to forecast the risk premia that have to be paid by other countries. Given the structure of their liabilities, this empirical finding should be of high relevance for portfolio and risk managers in the European life insurance industry and in pension funds. With regard to the yield spreads to be observed in the market for 10-year government bonds, there seems to be no clear picture. Focusing on fixed income securities with a maturity of 5 years, there is one very interesting empirical finding. The test results reported here seem to imply that there is unidirectional Granger causality running from the yield spreads in all other four countries to Austria. Given that Austria is a comparably small country which is assumed to be in a fiscally stable position, this result could be interpreted as evidence for credit risk premia as being helpful to forecast liquidity risk premia in the market for medium-term government bonds issued by member states of the European Monetary Union.

The Impact of the Introduction of Uniform European Collective Action Clauses on European Government Bonds as a Regulatory Result of the European Sovereign Debt Crisis

This paper conducts an empirical study on the inclusion of uniform European Collective Action Clauses (CACs) in sovereign bond contracts issued from member states of the European Union, introduced as a regulatory result of the European sovereign debt crisis. The study focuses on the reaction of sovereign bond yields from European Union member states with the inclusion of the new regulation in the European Union. A two-stage least squares regression analysis is adopted in order to determine the extent of impact effects of CACs on member states sovereign bond yields. Evidence is found that CACs in the European Union are priced on financial markets and that sovereign bond yields do respond to the inclusion of uniform CACs in the European Union.

A Frequency-Specific Factorization to Identify Commonalities with an Application to the European Bond Markets

AbstractWe propose a frequency-specific framework to link the common features in the multivariate high-frequency price jumps with the low-frequency exogenous factors. We introduce the measure of commonality and the measure of multiplicity based on high-frequency data and define the notions of coarrivals and cojumps to explore the contribution of individual assets. We employ the framework to study the 10-year high-frequency European government bond yields over June 2009–April 2019 as a function of macrofactors, macroannouncements, bond auctions, and unconventional monetary policy announcements. Both idiosyncratic and common jump arrivals are significant, with the idiosyncratic arrivals being more sensitive to financial distress as characterized by a low level of commonality in jump arrivals.

Safe-Asset Shortages: Evidence from the European Government Bond Lending Market

AbstractWe identify the unique role of the government bond lending market in collateral transformation during periods of market stress. Using a novel database, we provide evidence that safe assets in the lending market have higher demand, higher borrowing cost, and higher usage of noncash collateral relative to nonsafe assets during stressed market conditions. Moreover, we find that market participants are able to obtain safe assets using relatively low-quality noncash collateral, allowing for collateral transformation. We show that policy interventions by central banks can help reduce safe-asset shortages by returning sought-after safe assets to the market.

The COVID-19 Pandemic and Sovereign Bond Risk

Governments around the world are tackling the COVID-19 pandemic with a mix of public health, fiscal, macroprudential, monetary, and/or market-based policies. We assess the impact of the pandemic in Europe on sovereign CDS spreads using an event study methodology. We find that a higher number of cases and deaths and public health containment responses significantly increase the uncertainty among investors in European government bonds. Other governmental policies magnify the effect in the short run as supply chains are disrupted. Moreover, an increased debt-to GDP ratio significantly boosts the cumulative abnormal change of CDS spreads, which indicates that investors are concerned about countries that are too indebted and thus have a limited capacity to intervene and provide fiscal stimuli and emergency fiscal packages to businesses and households.

Volatility Indices and Implied Uncertainty Measures of European Government Bond Futures

Implied volatility and other forward-looking measures of option-implied uncertainty help investors carefully evaluate market sentiment and expectations. We construct several measures of implied uncertainty in European government bond futures. In the first part, we create new volatility indices, which reflect market pricing of subsequently realised volatility of underlying bond futures. We express volatility indices in both price and basis points, the latter being more intuitive to interpret; we document their empirical properties, and discuss their possible applications. In the second part, we fit the volatility smile using the SABR model, and recover option-implied probability distribution of possible outcomes of bond futures prices. We analyse shapes of the implied distribution, track its quantiles over time, calculate its skewness and kurtosis, and infer probabilities of a given upside or downside move in the price of bond futures or in the yield of their underlying CTD bond. We illustrate these complementary measures throughout the note using Bund futures as an example, and show the results for Schatz, Bobl, OAT, and BTP futures in the annex. Such forward-looking measures help market participants quantify the degree of future market uncertainty and thoroughly assess what risks are priced in.

Collateral haircuts and bond yields in the European government bond markets

Analyzing a novel collateral haircut dataset, this paper investigates the relations between the collateral haircuts and the yields of Euro-area central government bonds. The empirical analysis shows that investors demand higher yields for bonds with higher collateral haircuts. The importance of collateral haircuts on bond yields remains robust after controlling for the variations in credit quality, market liquidity and the effects of the European sovereign debt crisis.

Modeling intraday volatility of European bond markets: A data filtering application

This paper studies the intraday volatility of European government bonds under the framework of the multiplicative component GARCH model (Engle and Sokalska, 2012). Intraday return volatility is specified as the product of daily volatility, intraday seasonality, and a unit GARCH process. The model is applied to 10-year European government bonds during the sovereign debt crisis. We observe large transitory intraday volatility often due to illiquidity effects and outliers. We suggest a flexible and effective procedure for jointly filtering mid-quote prices and estimating volatility models. Finally, we show that intraday data contain relevant information for daily volatility forecasts.

Explosive behaviour and long memory with an application to European bond yield spreads

AbstractThis article deals with the interplay of explosive behaviour and long memory. We conduct Monte Carlo simulations and study the finite‐sample properties of the popular unit root test by Phillips et al. (2011) against explosive alternatives. This test exhibits severe upward size distortions under the presence of strongly autocorrelated residuals. We propose the usage of a set of adjusted critical values which leads to a size‐controlled test with increased power. As a complement, we consider the Lagrange Multiplier test against long memory by Tanaka (1999). We study European government bond yield spreads during the financial crisis.

Sovereign bond market dependencies and crisis transmission around the eurozone debt crisis: a dynamic copula approach

ABSTRACTWe examine the dependency between the European government bond markets around the recent sovereign debt crisis. A dynamic copula approach is used to model the time-varying dependence structure of those government bond markets, evaluate the nature and strength of their dependencies over time, and gauge the transmission of the crisis shocks. Our results can be summarized as follows: i) the eurozone sovereign bond markets under consideration have a significant and positive dependence with the Greek and the EMU benchmark sovereign bond markets; ii) the dynamic-BB7 copula function best describes the dependence structure between these sovereign bond markets and provides evidence of asymmetric tail dependence; iii) the conditional probability of crisis transmission from Greece to other eurozone countries is higher than the other way around; and iv) Greece is the most vulnerable country when the eurozone entered into the sovereign debt crisis.

Forecasting government bond spreads with heuristic models: evidence from the Eurozone periphery

This study investigates the predictability of European long-term government bond spreads through the application of heuristic and metaheuristic support vector regression (SVR) hybrid structures. Genetic, krill herd and sine–cosine algorithms are applied to the parameterization process of the SVR and locally weighted SVR (LSVR) methods. The inputs of the SVR models are selected from a large pool of linear and non-linear individual predictors. The statistical performance of the main models is evaluated against a random walk, an Autoregressive Moving Average, the best individual prediction model and the traditional SVR and LSVR structures. All models are applied to forecast daily and weekly government bond spreads of Greece, Ireland, Italy, Portugal and Spain over the sample period 2000–2017. The results show that the sine–cosine LSVR is outperforming its counterparts in terms of statistical accuracy, while metaheuristic approaches seem to benefit the parameterization process more than the heuristic ones.

Political Uncertainty and Sovereign Bond Markets

This paper analyzes the effects of political uncertainty on prices and liquidity of sovereign bonds. We focus on the time period of the European sovereign debt crisis and on Italian government bonds. We study the effect of Euro, G8 and G20 summits together with relevant elections. Focusing on Italy allows us to analyze a major European government bond market based on detailed transaction data, which was highly affected by the sovereign debt crisis. In line with the theoretical literature, we find a significant drop in prices in combination with high illiquidity and sell-side pressure before the event. Prices and trading activity start to recover approximately one month after the event when the impact uncertainty of policy changes resolves. The effects are stronger when uncertainty - measured by the EPU index - is high and the economic conditions are perceived as being weak.